Banks Take Center Stage (Reluctantly)

With rate cuts on the table, the bulls are charging ahead, but maybe not straight ahead.
Ed ZwirnJanuary 8, 2001

Call it a slightly confused bull.

The return of big name investment-grade issuers to the bond market had been predicted in a big way for January, and the surprise Fed move last week has done nothing to discourage that.

While the huge stock market rally engendered by the intra-meeting cuts of 50 basis points for both Fed Funds and the Discount Rate seems at this point to have been short lived, debt markets are in the middle of what looks like a more sustained, if less pronounced uptick.

Other than the obvious benefit to bonds of a declining interest-rate environment, primary and secondary debt markets for Treasuries, agencies and investment-grade paper are being lifted by a pronounced “flight to quality” — that is, away from stocks and other speculative investments.

While this will make it easier for some established firms to borrow money going forward, there remain significant trouble spots even in investment grade. And junk is seeing only a modest recovery.

Has the ‘Bleeding’ Stopped?

While most investment-grade paper has tightened about five or 10 basis points in the wake of the Fed’s Tuesday announcement, this tightening occurred just as the paper was hitting recent wide spreads. The Standard & Poor’s Index put its composite for five-year single-A bonds at 156 basis points over the five-year Treasury as of Dec. 29.

And with certain sectors of quality debt performing even more poorly, it is not surprising to see some heavy bargain hunting going on, especially on the part of banks.

Many banks see now as the time to unload mortgage-backed securities, which are outperforming Treasuries, and to buy corporate bonds and do so before the MBS refinance wave begins.

Of course, this means just about everything other than financial paper.

“Being a bank, we already have enough exposure to bank paper,” is the way one market professional puts it.

There are two other reasons that financial paper will be less in demand than other investment-grade debt over the short haul.

The first is supply. About 94 percent, or nearly $40 billion, of the U.S.-domiciled bonds slated to mature during January are in the financial sector, according to a report issued recently by Williams Capital Group. All of these will presumably need to be replaced.

Some heavy financial sector deals have already surfaced, including the $2.75 billion General Motors Acceptance Corp. five-year issue, which priced last week, and Citigroup’s planned $2 billion addition to its existing 6.75 percent senior notes, expected early this week.

In addition to supply concerns, there are the specific situations.

Bank of America, which at one point on Friday had its stock trading suspended, issued a terse statement that morning denying rumors that the firm had incurred derivative trading losses or other problems that would impair credit quality.

But reports that the bank is one of the leading lenders to PG&E Corp. and Southern California Edison have moved beyond the rumor stage. Although California officials have apparently stepped in to help the companies avoid bankruptcy for now, significant concerns remain about the basic structural problems that got these companies into their present fix. for more on this

But investment-grade debt is otherwise gathering steam. Star offerings expected in the near future include DaimlerChrysler, which is planning some $4 billion in dollars, euros, and sterling this week, and Genuity, a tech company which is planning a private (144a), two-tranche offering of $2 billion of Baa2/triple-B-plus bonds for “mid-January.”

The DaimlerChrysler deal is being handled by Deutsche Bank (of course), J.P. Morgan Chase, and Salomon Smith Barney. Genuity is being led by J.P. Morgan Chase and Solly.

In addition, media giant Viacom is planning a $1.5 billion three-part (five-, 10- and 30- year) offering via Merrill Lynch and Salomon Smith Barney, which will probably occur later this month.

In junk, several deals have hit the market, which seem to indicate a resurgence in the demand for high-yield firms with more solid backgrounds.

The darling in this department is Charter Communications, which on Friday priced its long-awaited deal via Morgan Stanley Dean Witter and Goldman Sachs. The offering at $1.75 billion was increased from an earlier discussed $1.2 billion.

The $900 million 8.75yr senior note piece was priced at 99.9 percent of face value to yield 10.75 percent; the $500 million 11.125 percent 10-year senior note leg was priced at par and is callable after five years; and the $350 million zero-13.5 percent 10-year senior discount notes were priced at 51.944 percent of face and also feature five years of call protection.

Another junk bond priced late last week was McleodUSA, which hit the scales with $750 million of 11.375 percent eight-year (B1/B+) senior notes at par, via Salomon Smith Barney and Goldman Sachs.

Late Friday, retailer Target Corp. sold $700 million of 6.35 percent coupon 10-year notes via Goldman Sachs and Salomon Smith Barney. The (A2/A-) issue, upsized from $500 million, priced at a discount to yield 6.381 percent, or 145 basis points over Treasuries.